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Why the RBA won’t cut rates tomorrow

Recent rate cuts around the world will increase the pressure for the RBA to follow suit, but our central bank could buck the trend.

The calls for an interest rate cut tomorrow have reached the pitch of cicadas on a stinking hot summer’s day. Once the various vested interests (such as housing market participants and bricks and mortar retailers) are discounted, there is still a strong core of respected economists and analysts chirping the rate cut song.

Market pricing is indicating a 60-80 per cent chance of a rate reduction. In my view, they’ll be disappointed.

There are some factors in favour of a cut. GDP growth at the last reading (Q3 2014) stood at 2.7 per cent per annum, a level that the RBA considers 'below trend'. Inflation is trending downward, and last Tuesday’s read showing a further fall in core readings to 2.3 and 2.2 per cent puts inflation at the bottom of the RBA’s preferred 2-3 per cent band, giving it room to move if it wishes. Manufacturing data is weak, and confidence is either mildly positive or mildly negative, depending on the survey. The transition in Australia, from mining-led growth to a broader economic basis for expansion, appears slow on some measures.

There is also the relative rate theory. Recent rate cuts from India, Canada and Denmark, and stimulatory moves in Europe and Singapore, increase the pressure for a cut locally.

Jobs and building approvals

However, the major driver of most cut calls is a forecast rise in unemployment. Many expect it to reach 6.5 per cent by mid-2015. These forecasts fly in the face of the two most recent monthly reads.

In November and December 80,000 net new jobs were created, driving the unemployment rate down to 6.1 per cent and the participation rate up. Unless January’s read reverses this short-term trend, reaching 6.5 per cent by June will look more and more difficult, which removes this central reason for lower interest rates.

Intended construction data, an important leading indicator, is also running against the doves. October and November building approvals both increased month on month, directly against consensus calls for falls. The annualised rate of increase stands at 10.1 per cent -- hardly a weak lead.

Stimulus – the Australian dollar, the ECB and oil

There are also external stimuli that could boost the Australian economy. The European Central Bank will start injecting euros into the global monetary system in March, and authorities in Japan are widely believed to be considering further policy initiatives. Europe and Japan are two of Australia’s top four trading partners, along with China and the USA, where growth prospects are much rosier.

These stimulus aspects are magnified by the fall in the Australian dollar. Since September, after the most recent GDP reading, AUD/USD has fallen from 0.94 to 0.78. Crude oil prices are down from $US95 to $US45 a barrel over the same period. These are significant positives for the Australian economy, and the impact has only just begun, and has not yet been measured.

There is also a reasonable basis to expect consumer confidence to rise. Lower oil prices mean lower petrol prices, giving consumers more to spend elsewhere. Asset prices (noticeably housing and shares) are up on a year ago, another factor that could help swing confidence higher.

Surprise and signalling

Perhaps the most important reasons to think the RBA will not move tomorrow are cultural. RBA governor Glenn Stevens has fostered an unprecedented level of central bank transparency. He has remarked in the past that RBA statement language ‘evolves’. In this environment, the regularly inserted phrase “an extended period of interest rate stability” deserves to be taken seriously.

While the SNB, Reserve Bank of India and the Bank of Canada have all surprised markets in the last two weeks, for the RBA to do so would require a cultural 180 degree swing. This doesn’t mean the RBA will never surprise markets again; it’s just that a much more compelling economic case is required.

There is also the issue of an article by Terry McCann last Thursday, using definitive language to more than suggest the RBA will cut next week. Some years ago McCrann was uncannily accurate in forecasting RBA actions, and some believe the article was an attempt to soften the markets ahead of a cut. However, Stevens has asserted that the RBA does not spill to the press, and has imposed a media blackout in the lead up to its monthly meetings. McCrann’s call may make a cut tomorrow more difficult, as the RBA could be wary of creating the impression that a journalist has inside information on RBA deliberations.

On balance, the Australian economy is okay -- neither booming nor busting. Various RBA board members have discussed the need for an unleashing of ‘animal spirits’, the creative economic forces that drive growth. Confidence, in business and from consumers, is required. Cutting interest rates would signal that the RBA is worried about the outlook, which would in turn undermine confidence. The case is not strong enough for the RBA to damage its reputation with an unheralded rate cut tomorrow.

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